Articles Tagged with Dodd Frank Wall Street Reform And Consumer Protection Act

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Written by Michael Wu

The Securities and Exchange Commission (the “SEC”) recently published a notice of its intent to raise the dollar thresholds that would need to be satisfied in order for an investment adviser to charge its investors a performance fee.  Currently, under Rule 205-3 of the Investment Advisers Act of 1940, as amended, an investment adviser may charge its investors a performance fee if (i) the investor has at least $750,000 under management with the investment adviser, or (ii) the investment adviser reasonably believes that the investor has a net worth of more than $1.5 million.  To comply with the Dodd-Frank Act, the SEC must adjust these dollar amounts for inflation by July 21, 2011 and every five years thereafter.

Thus, the SEC intends to issue an order that would revise the dollar amount tests to $1 million for assets under management and $2 million for net worth.  The SEC is also proposing to amend Rule 205-3 to: (i) provide the method for calculating future inflation adjustments of the dollar amount tests, (ii) exclude the value of a person’s primary residence from the net worth test, and (iii) modify the transition provisions of the rule.  The SEC is seeking public comment on the proposed rule.

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Written by Jay Gould, Ildi Duckor and Michael Wu

On March 22, 2011, U.S. House Oversight Committee Chairman Darrell Issa (R., Calif.), sent a sharply worded letter to Chairman Mary Schapiro of the Securities and Exchange Commission (the “SEC”), in which he demanded that the SEC justify several of its rules regarding raising capital, including the “quiet period” that restricts a company’s communications ahead of an initial public offering (“IPO”) and the rules that limit the number of investors in private companies to 499. The immediate impetus of this letter (the “Issa Letter”) appeared to be the recent decision by Facebook to issue shares exclusively to non-U.S. investors due to the requirement for a private company to file financial statements with the SEC once it has more than 499 U.S. equity holders, as well as the general decline of the overall IPO market in the U.S.

The Issa Letter accuses the SEC of stifling capital creation and causing the decline of the IPO market in the U.S. by clinging to obsolete and inflexible laws and regulations. Chairman Issa asks whether the decline in public equity listings and issuances have been driven by the expansion and complexity of SEC regulations, the expansion of personal liability under the Sarbanes-Oxley Act of 2002, the new uncertainty surrounding regulations to be issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), securities class action lawsuits and the expansion of other regulatory, legal or compliance burdens. Chairman Issa railed against the prohibition on promotional statements made between the time that a registration statement has been filed and the time it becomes effective as a violation of an issuer’s rights under the First Amendment. Chairman Issa further finds fault in the inability of the SEC to fashion rules to permit effective early stage capital formation, accuses the SEC of certain conflicts of interest and ineptitude in its staff, and suggests that “sophisticated” investors, regardless of whether they satisfy the “accredited” investor standard, should be permitted to invest in private placements.

On April 6, 2011, Chairman Schapiro responded to Chairman Issa in a detailed and heavily footnoted tome (the “Shapiro Letter”) that sought to correct some of the basic misunderstandings in the Issa Letter. The Schapiro Letter provides an interesting and brief history of the development of private offerings, the development of the private markets, the IPO process, the rationale behind public reporting, and the SEC’s views towards capital raising strategies. Much of this discussion is either relevant to investment fund managers or directly on point with their businesses, and certainly worth a read.

Chairman Issa raises some interesting points and the combative tone of his letter should not be a reason to simply dismiss his concerns. There are, however, two interesting questions that Chairman Issa could have raised with the SEC, but did not, the answers to which may have been even more productive to the discussion.

First, does the SEC believe that if it was self-funded, it would be more responsive to the needs of the capital markets and be able to better balance its dual mandates of creating efficient capital markets and protecting shareholders? It should be noted that early drafts of the Dodd-Frank Act stated that the SEC was to be self-funded, but that language was later removed when our two political parties agreed on specific budget numbers for the SEC, which they believed would permit the SEC to meet its significant new and continuing obligations. Once the Dodd-Frank Act became law, a bi-partisan Congress promptly ignored these funding mandates and has continued to impede the effectiveness of the SEC through the budget process.

Second, does the SEC believe that significantly increasing the number of investors to which a private company can sell shares, without providing full and fair disclosure, would shrink the public markets, make fewer investment opportunities available to ordinary investors, and accelerate the wealth divide that is threatening to destabilize the U.S.? The securities laws were meant to level the playing field among investors, and the SEC over the years has attempted to enforce this mandate through the registration process and its enforcement actions. Larry Ribstein provides a thoughtful view of this dilemma here.

The balance between effective regulation for investor protection and efficient capital markets to encourage responsible investment is a delicate one that we can expect to be treated quite indelicately in the current political climate.

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Written by Michael Wu

On December 7, 2010, the Securities and Exchange Commission (the “SEC”) proposed joint rules with the Commodity Futures Trading Commission (the “CFTC”) to define the types of swap traders that would be subject to the new derivatives regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The proposed rules attempt to implement the provisions of the Dodd-Frank Act, which established a comprehensive framework for regulating the over-the-counter swaps market.

The Dodd-Frank Act creates new categories of market participants that are subject to registration, capital and margin, record keeping, reporting and other regulatory requirements.  The proposed rules define the categories of market participants that would be deemed “Security-Based Swap Dealers” and “Major Security-Based Swap Participants.”

  • Security-Based Swap Dealers.  Under the Dodd-Frank Act, a Security-Based Swap Dealer is any person that holds itself out as a dealer in security-based swaps, makes a market in security-based swaps, enters into security-based swaps with counterparties in the ordinary course of its business, or is commonly known in the trade as a dealer or market maker in security-based swaps.  The CFTC proposal would exempt a firm from registration as a Security-Based Swap Dealer if (i) its notional aggregate amount of security-based swaps in the prior 12 months did not exceed $100 million (of which only $25 million can be with “special entities” as defined in the Commodity Exchange Act), (ii) it did not enter into security-based swaps as a dealer with more than 15 counterparties (other than security-based swap dealers) in the prior 12 months, and (iii) it did not enter into more than 20 security-based swaps as a dealer in the prior 12 months.
  • Major Security-Based Swap Participants.  Under the Dodd-Frank Act, a Major Security-Based Swap Participant is any person that is not a Security-Based Swap Dealer and has (i) a “substantial position” in any major security-based swap categories (held other than for hedging or mitigating risk), (ii) whose security-based swaps create “substantial counterparty exposure,” which could have a serious adverse effect on the financial stability of the United States banking systems or financial markets, or (iii) is a “financial entity” that is “highly leveraged” and that has a substantial position in any of the major security-based swap categories.
    • The CFTC proposed that a firm has a “substantial position” in swaps if it (i) has a daily average or current uncollateralized exposure of at least $1 billion on a net basis for credit, equity or commodity swaps or $3 billion for rate swaps, or (ii) has a daily average of current uncollaterized exposure and future exposure of at least $2 billion for credit, equity or commodity swaps or $6 billion for rate swaps.
    • The CFTC proposed that a firm has “substantial counterparty exposure” if it has uncollateralized exposure of more than $5 billion or current and future exposure exceeding $8 billion.
    • The CFTC proposed that a “financial entity” be defined under Section 3C(g)(3) of the Securities Exchange Act of 1934, as amended.
    • The CFTC proposed two definitions of “highly leveraged”; the first is an 8 to 1 ratio of total liabilities to equity determined in accordance with US GAAP and the second is a 15 to 1 ratio of total liabilities to equity determined in accordance with US GAAP.

In addition, the proposed rules permit clearinghouses to provide portfolio margining of futures and securities in futures accounts.  The proposed rules also require Security-Based Swap Dealers and Major Security-Based Swap Participants to keep daily trading records regarding the security-based swaps and all related records, which would be open to inspection by the CFTC.  The CFTC and the SEC are expected to vote on the final rule in July of 2011.

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Written by Michael Wu

On Friday, November 19, 2010, the Securities and Exchange Commission (the “SEC”) issued a Proposed Rule amending the Investment Advisers Act of 1940, as amended, and a Proposed Rule implementing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The purpose of the proposed rules is to strengthen the SEC’s oversight of investment advisers and fill key gaps in the regulatory landscape. The following is a summary of the key provisions of the proposed rules.

Increased Disclosure for Registered Advisers:  Under the proposed rules, advisers to private funds would have to provide the following information about the private funds they manage:

  • Basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser’s services to the fund.
  • Identification of five categories of “gatekeepers” that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).

In addition, the proposed rules would require registered advisers to provide more information about their advisory businesses, including information about:

  • The types of clients they advise, their employees, and their advisory activities.
  • Their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals).

The proposed rules also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Increased Disclosure for Exempted Advisers:  The proposed rules would require exempt reporting advisers (i.e., advisers that are exempt because they only advise venture capital funds or advise private funds with less than $150 million in assets under management (“AUM”)) to file, and periodically update, reports with the SEC, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including:

  • Basic identifying information for the adviser and the identity of its owners and affiliates.
  • Information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
  • The disciplinary history of the adviser and its employees that may reflect on their integrity.

As with registered advisers, exempt reporting advisers would file the reports on the SEC’s investment adviser electronic filing system (IARD), which means that such reports would be publicly available.

Pay-to-Play:  The proposed rules would amend the current investment adviser “pay-to-play” rule in response to changes made by the Dodd-Frank Act. The pay-to-play rule prohibits advisers from engaging in pay to play practices.  Under the proposed rules, an adviser could pay a registered municipal adviser, instead of a “regulated person,” to solicit government entities on its behalf if the municipal adviser is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule.

Dodd-Frank Act Exemptions:  Under the Dodd-Frank Act, the following advisers would not need to register with the SEC: (i) advisers solely to venture capital funds; (ii) advisers solely to private funds with less than $150 million in AUM in the U.S. or (iii) certain foreign advisers without a place of business in the U.S.  The proposed rules provide further guidance regarding these exemptions.

Definition of Venture Capital Fund:  Under the proposed rules, a venture capital fund is a private fund that:

  • Represents itself to investors as being a venture capital fund.
  • Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash.
  • Is not leveraged and its portfolio companies may not borrow in connection with the fund’s investment.
  • Offers to provide a significant degree of managerial assistance, or controls its portfolio companies.
  • Does not offer redemption rights to its investors.

Under a grandfathering provision, private funds that currently make venture capital investments and represent themselves as venture capital funds would generally be deemed to meet the proposed definition.

Definition of Private Fund Advisers with less than $150 million AUM in the U.S.:  Under the proposed rules, in order to rely on this exemption, a U.S. adviser would have to meet the conditions of the exemption with respect to all of its private fund AUM. A foreign adviser would have to meet the conditions of the exemption only with respect to its AUM in the U.S., but generally not with respect to its assets managed from abroad.

Definition of Foreign Private Advisers:  The proposed rules would define certain terms included in the statutory definition of “foreign private adviser” in order to clarify the application of the foreign private adviser exemption. The proposed rules incorporate definitions set forth in other SEC rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.

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The Securities and Exchange Commission and Commodity Futures Trading Commission recently adopted interim final rules for the reporting of swaps that were entered into prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and had not expired as of July 21, 2010 (“pre-enactment swaps”). The adoption of these rules was mandated by the Dodd-Frank Act, which required the SEC and CFTC to adopt rules for the reporting of pre-enactment swaps within 90 days of the enactment of the Dodd-Frank Act.

Reporting Obligations

The requirements of the SEC and CFTC rules are substantially similar. They require specified counterparties to pre-enactment swaps to provide to a registered swap data repository or the relevant Commission:

  • a copy of the transaction confirmation, in electronic form, if available, or in written form, if there is no electronic copy; and
  • the time, if available, the transaction was executed.

In addition, a counterparty to a pre-enactment swap is required to report to the relevant Commission upon request any information relating to such swap during the time that the interim final temporary rule is in effect. Such information may include actual trade data as well as summary trade data. Summary data may include a description of the types of a swap dealer’s counterparties or types of reference entities, or the total number of pre-enactment swaps entered into by the dealer and some measure of the frequency and duration of those contracts.

Reporting Party

The new rules require the following parties to report swaps:

  • with respect to a swap in which only one counterparty is a swap dealer or major swap participant, the swap dealer or major swap participant must report the swap;
  • with respect to a swap in which one counterparty is a swap dealer and the other counterparty is a major swap participant, the swap dealer must report the swap;
  • with respect to any other swap, the parties to the swap must select a reporting party.

Record Retention

Each counterparty to a pre-enactment swap that may be required to report such swap must retain information and documents relating to the terms of the transaction. Specifically, such counterparties must retain all information and documents, if available, to the extent and in such form as they currently exist, relating to the terms of the swap, including but not limited to:

  • any information necessary to identify and value the transaction;
  • the date and time of execution of the transaction;
  • all information from which the price of the transaction was derived;
  • whether the transaction was accepted for clearing by any clearing agency or derivatives clearing organization, and, if so, the identity of such clearing agency or derivatives clearing organization;
  • any modification(s) to the terms of the transaction; and
  • the final confirmation of the transaction.

Effective Date

The record retention requirements are effective immediately. Reporting obligations will become effective on the earlier of (i) the compliance dates established by the SEC and CFTC in future rulemaking or (ii) 60 days after a registered swap data repository commences operations.

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Under Secretary for International Affairs Lael Brainard recently delivered a speech at the Institute of International Bankers’ “Regulatory Dialogue with Government Officials” urging other nations to adopt the U.S. approach to hedge fund regulation:

It is also vital to have common agreement on the regulation of hedge funds, and to extend the perimeter of regulation to ensure stronger oversight of these funds. We have pursued international agreement on the same approach adopted by the United States: requiring all advisers to hedge funds, above a threshold, to register and report appropriate information so that regulators can assess whether any fund poses a threat to overall financial stability by virtue of its size, leverage, or interconnectedness. And to impose heightened supervisory and prudential standards on entities that do.

It is essential to ensure convergence of regulatory treatment for hedge funds to avoid a race to the bottom and promote a level playing field. Indeed, all the members of the G-20 committed to the same standards for oversight of hedge funds and to implementing these standards in a nondiscriminatory manner, and we are working hard to ensure these commitments are fulfilled.

The full text of the speech is available here.

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The Securities and Exchange Commission has proposed a new rule under the Dodd-Frank Wall Street Reform and Consumer Protection Act to define the term “family offices.” Advisers falling within this definition will be excluded from the definition of “investment adviser” under the Investment Advisers Act of 1940 and will therefore not be required to register with the SEC. Many family offices had previously relied on the “private adviser exemption” from registration, which exempted advisers with fewer than 15 clients from the registration requirement of the Advisers Act. As we have previously discussed, the Dodd-Frank Act removed the private adviser exemption from the Advisers Act.

Proposed Rule 202(a)(11)(G)-1 defines a family office as any firm satisfying the following three conditions:

  • Family Clients. Family offices may only provide investment advice to “family clients.” Family clients include family members, certain employees of the family office, charities established and funded exclusively by family members, trusts or estates existing for the sole benefit of family clients and entities wholly owned and controlled by family clients. Former family members may retain investments held through a family office but may not make new investments.
  • Ownership and Control. The family office must be wholly owned and controlled by family members.
  • Holding Out. The family office may not hold itself out to the public as an investment adviser.

The SEC noted that a family office that fails to meet the requirements of the new rule would still be able to seek an exemptive order from the SEC.

Comments on the proposed rule must be received by the SEC by Nov. 18, 2010.

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On September 22, 2010, the Managed Funds Association submitted initial comments to the Securities and Exchange Commission and the Commodity Futures Trading Commission on regulatory topics under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The MFA’s comments reflected concerns that the broad wording of the Dodd-Frank Act would result in certain provisions being inappropriately applied to private investment funds. To address these concerns, the MFA proposed that:

  • the SEC not create a self-regulatory organization to oversee investment advisers;
  • the SEC and the CFTC adopt guidance clarifying the criteria relevant to determining whether an investment adviser or a CTA that is registered with one of the agencies can rely on the relevant exemption from registration with the other agency;
  • strong confidentiality safeguards be put in place to protect proprietary information of private fund advisers provided to the SEC or CFTC;
  • appropriate implementation periods be provided to allow market participants time to adjust to any change in the definitions of “accredited investor” or “qualified client;”
  • the SEC define “accredited investor” to include “knowledgeable employees” of a private investment fund and amend Rule 3c-5 under the Investment Company Act of 1940 to expand the types of employees who can qualify as “knowledgeable employees” under that Rule;
  • the SEC and CFTC define “Security-Based Swap Dealer” (“SSD”) to exclude those market participants who are not in the business of buying and selling securities as well as those who buy and sell for their own account;
  • the SEC and CFTC exclude swap customers from SSD registration and regulation with respect to their cleared security-based swaps;
  • in setting capital requirements for non-bank Major Security-Based Swap Participants (“MSSPs”), the SEC and CFTC count collateral posted by such non-bank MSSPs towards any capital requirements;
  • position limits not be imposed on swaps;
  • the SEC not apply rules prohibiting incentive-based compensation to advisers of private investment funds;
  • the SEC retain the existing reporting periods under Section 13(d) and Section 16(a) of the Securities Exchange Act of 1934; and
  • the SEC not impose a new standard of conduct for investment advisers with retail customers.
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The Securities and Exchange Commission has published its schedule for adopting rules to implement the Dodd-Frank Act. The proposed timetable for adopting rules related to the oversight of investment advisers and exempt offerings is as follows:

October – December 2010

  • §§404 and 406: Propose (jointly with the CFTC for dual-registered investment advisers) rules to implement reporting obligations on investment advisers related to the assessment of systemic risk
  • §§407 and 408: Propose rules implementing the exemptions from registration for advisers to venture capital firms and for certain advisers to private funds
  • §409: Propose rules defining “family office”
  • §410: Propose rules and changes to forms to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act
  • §418: Propose rules to adjust the threshold for “qualified client”
  • §413: Propose rules to revise the “accredited investor” standard
  • §926: Propose rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated

January – March 2011

  • §913: Report to Congress regarding the study of the obligations of brokers, dealers and investment advisers
  • §914: Report to Congress regarding the need for enhanced resources for investment adviser examinations and enforcement
  • §919B: Complete study of ways to improve investor access to information about investment advisers and broker-dealers

April – July 2011

  • §§404 and 406: Adopt rules (jointly with the CFTC for dual-registered investment advisers) to implement reporting obligations on investment advisers related to the assessment of systemic risk
  • §§407 and 408: Adopt rules implementing the exemption from registration for advisers to venture capital firms and to certain advisers to private funds
  • §409: Adopt rules defining “family office”
  • §410: Adopt rules and form changes to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act
  • §418: Adopt rules to adjust the threshold for “qualified client”
  • §413: Adopt rules to revise the “accredited investor” standard
  • §926: Adopt rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated
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In its first regulation implementing the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission announced today its adoption of a temporary rule requiring municipal advisors to register with the SEC by October 1, 2010.

“Municipal advisors” are persons who provide advice to a state or local government regarding municipal derivatives, guaranteed investment contracts, investment strategies or the issuance of municipal securities. The term is also defined to include persons who solicit business for these advisory services from a state or local government on behalf of a third party broker, dealer, municipal securities dealer, municipal advisor or investment adviser.

Municipal advisors must register with the SEC by completing and submitting new Form MA-T, which requires a municipal advisor to disclose certain basic identifying and contact information concerning its business, indicate the nature of its municipal advisory activities, and supply information about its disciplinary history and the disciplinary history of its associated municipal advisor professionals. Municipal advisors must amend the form whenever any identifying or contact information or disciplinary information has become inaccurate in any way.

Form MA-T and the Municipal Advisor Temporary Registration website can be accessed through the SEC’s website. Given the need to obtain an ID and password prior to submitting Form MA-T, it is recommended that municipal advisors begin the registration process immediately.